Why Investors Are Now Giving Up

After the market rout of the past year and a half, countless investors are re-thinking some of their most cherished maxims: Are stocks really a good long-term vehicle for creating wealth? Is buy-and-hold dead? Should I just stuff my retirement money under my mattress?

Some discouraged investors have decided to take the path of least resistance -- they've thrown in the towel and resigned themselves to never beating the market.

Content to be averageAccording to data from Lipper, investors yanked over $221 billion out of actively-managed mutual funds in 2008. So, where did that money go? Well, a big chunk of it was funneled into passively-managed index funds and exchange-traded funds like Spiders (NYSE: SPY) and the iShares Russell 1000 Index (NYSE: IWB) . Index funds saw new inflows of over $17 billion last year, bumping up their share of the mutual fund market to 13.2%. Apparently, scores of investors are giving up on ever being able to outperform the market and are content to merely match its return.

And who can blame them? Many actively-managed funds have done a dismal job of keeping pace with the market during this most recent downturn, losing more ground than some benchmark indices. Some fund shops were caught flatfooted by the crisis in the financial arena and lost big on names like Citigroup (NYSE: C) and Fannie Mae (NYSE: FNM) .

Furthermore, it's absolutely true that the vast majority of active mutual funds don't beat the market. It leads one to wonder why you should pay for the advice of a fund manager if you're just going to lag the market anyway. Why not just throw your money in an index fund and be done with it?

Diamonds in the roughWhile abandoning the game of trying to outperform the market may be appealing in tough times, if you do give up, you're leaving a lot of money on the table. And while they definitely have their problems, I wouldn't count actively-managed funds down for the count just yet.

It's true that most such funds simply can't beat the broader market over the long-run, but there are a select number of exceptionally skilled managers who do manage to trounce the market. The problem lies in finding these needles in a haystack of competitors. Fortunately, there are a few easily identifiable features that almost all top-notch funds have in common.

In the Winners' CircleOne of the first things to look for is funds with a long-tenured manager or management team at the helm. Numerous academic studies, such as a 2004 study in The Journal of Investing performed by Greg Filbeck and Daniel Tompkins, have proven that funds with longer-tenured managers tend to outperform funds with newer talent on board. For example, the Stratton Multi-Cap Fund (STRGX) has been run by manager James Stratton since its inception in 1972. For more than three-and-a-half decades, Stratton has invested in high-quality companies like Owens-Illinois (NYSE: OI) , Harris Corporation (NYSE: HRS) , and Schnitzer Steel Industries (Nasdaq: SCHN) -- and racked up a first-rate track record doing so. Over the recent 15-year period, the fund outranks 96% of its peers!

Low expenses are another hallmark of top-performing funds. Of course, common sense tells you that lower fees mean that it's easier to top the market, since you're getting more of a return for your money! Some of those same academic studies that highlight the importance of manager tenure have also proven that lower-priced funds tend to do better in the long-run than their more expensive counterparts. Likewise, if you own funds in a taxable account and tax efficiency is important to you, look for funds with a low annual turnover.

When putting funds under the microscope, make sure you choose one that has utilized the same consistent investment process over a long span of time. You don't want a fund that changes its stripes when certain investment styles or fads come into fashion, but one that relies on its core expertise and style of investing. One big thing to look out for here is small-cap funds that have gotten too big for their britches and now lean more heavily into mid-cap and large-cap space, thanks to an oversized asset base.

Lastly, while past performance is usually the most important factor investors use in purchasing mutual funds, it should really only be examined after you make sure a fund meets all of the above criteria. Look at how a fund has performed in both good and bad market environments. This should give you some indication of how it will perform in those types of markets in the future. Like the disclaimers say, there is no guarantee of future performance, but choosing a fund that has added value in both bull and bear periods increases the odds that the fund will outperform in the coming years.

Of course, if you want to save yourself the work and find out with one easy glance which mutual funds amongst the thousands out there measure up to these exacting standards, check out the Fool's Champion Funds investment service today. As the lead advisor, I strive to find winning recommendations each month. After five years, our recommendations have returned an average of 12%, while equal amounts invested in the S&P 500 would have lost 22%. You can see all our winning fund picks with a free 30-day trial.

Some investors may have given up on trying to beat the market, but that's no reason you have to. There's money to be made for Foolish investors -- you just have to know where to look.

Amanda Kishheads up the Fool's Champion Funds newsletter service. At the time of publication, she did not own any of the companies mentioned herein. The Fool owns shares of SPDRs. Clickhereto find out more about the Fool's disclosure policy.

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Another shameless promotional piece for actively managed funds. Let's see, there are only a handful of things you need to check to find the best funds and with a paid subscription to the newsletter they will do all the work for you!

Problem: are the newsletter recommendations good for one week, one month or one year? good for several years? Will the newsletter call you up when things change or do you have to subscribe and read for life so that you can be prepared to make sudden changes when things suddenly change at the recommended funds?

So you pay a fee to have your money actively managed but you still have to continuously monitor all the "magic factors", either yourself or subscribing to a "newsletter", to see if you need to make changes? What a load (pun intended)!

I have over 30 years of experience with mutual funds, both self-researched and preselected for 401K's and other pension investments. They all stunk over the long term, and short term for that matter. Most lost money even in bull markets. Anyone who gives their money to a mutual fund in hopes that the management they pay for will be worth it is a Fool. I have, however, made money in Index Funds, but market timing of some degree (buying on dips in the market) and selling on indicators (higher anticipated interest rates) is essential. Other than that, buying stocks is always speculation to some degree and long term holds have proved disastrous as there is no longer any corporate transparency. I don't think the market is a Casino, but I do think it is rigged to a great extent in favor of the professional and all the information on MF times 911 will not make you a professional. One must trade on good information and with insight, but expect the unexpected, which is why the equity market is not an "investment." Oh, yeah, I've tried gold both coins and bullion; the commissions are ridiculous for retail investors. In the recent bull market for gold my net profit was only modest after fees, etc. even though spot gold more than doubled. I would never consider gold an investment anyway, only a hedge against inflation at best, since it never throws off profit being commodity that produces nothing. Best bet for investing: Series I Bonds as long as you have some faith that the USA is basically secure and a window of 5 years. Rates on Series I Bonds adjust according to inflation; that's an investment. But, unfortunately, Series I Bonds in an IRA, as far as I know.

Mutual Funds had a good ride, and hopefully the scam is over and they go belly up. The investors got nothing back but statements showing the fees and expenses they paid for these nitwits to lose money.

My advice: Never invest in a mutual fund again. Buy stock in companies that pay dividends. At least it's some kind of report card every few months. And use a brokerage company with a set fee for your transactions. Like $9.99. Anymore than that is out of the question.

I disagree strongly with many of the negative comments about mutual funds. Making blanket statements saying every mutual fund is like every other mutual fund shows real financial ignorance. That's like having food poisoning and declaring all food to be no good, or having a car accident and declaring all cars to be no good. Some of you folks sound like you are truly fools!

For the past ten years - since going on early retirement - I have channelled all my investments into my own specifically researched and chosen mutual funds. I have gone this route as I can then invest in the particular mix of companies which make up the fund ( as opposed to individual equities ), and which I believe will over time outperform the market average.

Until the market crash we have just had - and which has wiped out about 30% of my value, I have been able - year on year - to fully cover all my drawings ( salary ) as well as achieve growth of about 8/10 % PA . I believe that provided you have at least a good understanding of all the financial issues which are pertinent - and approach your investments by very thoroughly researching all elements of your choices, you can make a fair living this way.

I concentrate my investments in a portfolio of 10 or 12 big calls - and make perhaps 3 or 4 switches during the average year. It has worked for me so far. However, I do enjoy keeping up to speed with financial issues - and spend a lot of time and approach my investments just as I would a full time job !